The Long Island Lighting Company (LILCO) has reached an agreement in
principle with the Long Island Power Authority (LIPA) on a corporate restructuring
plan. Under the plan, LIPA would acquire LILCO through a leveraged buy-out,
in which borrowed funds finance a takeover, and the cash flow of the acquired
company is used to repay the debt. LIPA plans to issue tax exempt municipal
debtto accomplish the transaction.
The financial structure of the deal includes the following:

LIPA would issue new bonds in the amount of $7.594 billion through
multiple offerings. The financial deal, if issued at once, would constitute
the largest municipal debt ever issued in the nation.

LIPA's initial debt profile would be $8.07 billion, which includes
$476 million in debt assumed, but not refinanced, from LILCO. LIPA also
plans to issue bonds for capital expenditures over the next ten years.
LIPA will either assume without refinancing or issue new debt totaling
over $9 billion.

Over the term of the bonds issued during the first 10 years, debt service
payments would total $23.446 billion, including $14.301 billion in interest
and $9.145 billion in principal.

Each customer would pay approximately $23,000 in total debt service
over the life of the bonds, including $14,000 in interest and $9,000 in
principal. Each of LIPA's customers would effectively pay an average of
$400 in interest per year over the next 35 years.

LIPA effectively borrows $502 million in its first two debt issuances
to be repaid over the next 35 years to subsidize rates over the first ten
years.

LIPA's obligations are projected to exceed its revenues by over $1.322
billion in the third through the tenth year. Covering this deficit requires
utilizing funds that would otherwise have reduced the need for borrowing.

On average, LIPA will only finance 20 percent of its total capital
improvement needs over the next 10 years with internally generated cash.
In contrast, LILCO has funded all of its capital improvement needs over
the last few years with internally generated cash.

The value of the fixed assets to be purchased by LIPA represents only
a quarter of the overall purchase price. Consequently, bondholders will
be unable to secure their position with collateral, as is generally becoming
commonplace in the industry, and will look for alternative forms of security.

DESCRIPTION OF LIPA PROPOSAL

The major components of the proposed purchase transaction include the
following:

LIPA would initially issue $7.594 billion in tax-exempt municipal bonds
(see Table 1 for details related to the use of bond proceeds), in multiple
offerings.

LIPA would use $2.837 billion in bond proceeds to acquire LILCO's common
and preferred stock.

Acquisition of stock by LIPA would represent ownership of transmission
and distribution, nuclear, regulatory and other assets. LIPA would settle
the Shoreham property tax certiorari litigation as part of the deal.

LIPA would assume $3.684 billion of LILCO debt, of which $3.208 billion
would be refinanced with bond proceeds.

LILCO would receive $2.5 billion in cash from the transaction.

THE SIZE OF THE LIPA PROPOSAL

Many different numbers have been used to describe the magnitude of the
proposed LIPA buy-out of LILCO. Public discussions and press accounts of
the deal have revealed numbers in the range of $6 billion to $8 billion,
with $7.2 billion and $7.3 billion among the most commonly quoted amounts.

Table 1 provides the reader with a detailed description of the amounts
LIPA proposes to borrow over the next ten years to effectuate the deal
and provide rate savings through the new capital structure.

Table 1 Ten-Year LIPA Bonding

Use of Bond Proceeds

Amount (millions)

Proposed Initial Bond Issuance(s)

Purchase Common Stock

$ 2,498

Redeem Preferred Stock

339

Refinance Debt

3,208

Issuance and Other Related Costs

911

Conservation and Advocacy Funds

33

Capital Construction - First Year

130

Shoreham Settlement - First Payment

143

Total Bonds for Initial Transaction

$ 7,262

Shoreham Property Tax Settlement
-Years 2-5

332

Total New LIPA Debt

$ 7,594

Additional Debt Assumed from LILCO

476

Initial LIPA Debt Profile

$ 8,070

Capital Expenditures - Years 2-10

1,075

Total Proposed LIPA Debt

$ 9,145

Potential Purchase of Generation
Assets *

$ 639

* The
$639 represents net book value as of 12/31/97. Under the deal, price would
be set at fair market value if LIPA elects to purchase LILCO's generation
assets.

Source: Long Island Power Authority

The Table first identifies the uses of LIPA's initial new borrowing
of $7.262 billion (the number most commonly referred to in descriptions
of the deal), which would take place through three bond issues and would
allow the initial purchase transaction to take place. The bond proceeds
would be used to purchase common and preferred stock of LILCO, as well
as to refinance $3.208 billion out of the $3.684 billion debt which LIPA
would assume from LILCO. In addition, the proceeds would finance the first
payment related to the Shoreham tax settlement and capital expenditures
for the first year. Table 1 also includes future borrowing necessary for
the functioning of the transmission, distribution and nuclear assets to
be acquired by LIPA.

As part of its deal with LILCO, LIPA would settle the Shoreham property
tax litigation. The Shoreham property tax settlement would involve additional
bonding over the four years following the initial debt issuances, bringing
the total new LIPA debt to $7.594 billion1.
Also, as part of the $3.684 billion in debt assumed by LIPA from LILCO,
$476 million would not be refinanced. As Table 1 demonstrates, the addition
of this assumed debt increases LIPA's initial debt profile to $8.07 billion.

The total proposed LIPA debt, as depicted in Table 1, would rise to
$9.145 billion, due to LIPA's plan to issue $1.075 billion in bonds over
the next ten years to finance capital expenditures. Additional debt would
be incurred by LIPA, if it decides to exercise its option in the fourth
year to purchase LILCO's generation plants. LIPA might also incur debt
if, as part of its fifteen year power supply contract with LILCO, it chooses
to reduce the amount of power purchased from LILCO in year seven, in which
case LIPA would be required to pay a percentage of the present value cost
of the remaining capacity charges.

DEBT SERVICE COSTS OF THE LIPA BONDS TO RATEPAYERS

Figure A depicts the debt service profile on the initial $8.07 billion
in LIPA debt, necessitating revenue requirements be charged to ratepayers
over the next 35 years. LIPA's ratepayers will pay a total of $12.94 billion2
in interest on this initial debt over the life of the bonds. This initial
debt service profile translates into each customer on Long Island paying
almost $13,000 in interest and approximately $8,000 in principal.

Under LIPA’s financing proposal, which structures the repayment schedule
to produce levelized annual payments, annual debt service would plateau
at $625 million after the tenth year on the initial $8.07 billion in debt.
The profile indicates that no principal would be repaid in the years 1998
and 1999, limiting debt service payments to $492.5 million in interest
only. Between years two and three, debt service increases by over $78 million,
reflecting the repayment of principal. During the ensuing years, LIPA's
rates will reflect even higher debt service requirements as a result of
the delay in principal repayment.

Under the LIPA plan, additional borrowing would occur at a faster rate
than the repayment of principal during the early years. Even after the
second year, when LIPA starts to repay principal, total outstanding principal
continues to increase due to the issuance of bonds for the Shoreham property
tax settlement and capital improvement expenditures. Under this plan, a
total of $9.145 billion in bonds would be issued over the initial ten years.

Figure B shows the total proposed LIPA debt service profile for $9.145
billion in bonds. This profile includes the $1.075 billion in debt to be
issued for capital expenditures as noted above and in Table 1. Figure B
provides a more complete picture of the annual debt service requirements
of LIPA’s plan in the first ten years, showing annual debt service will
exceed $700 million in the tenth year.

Furthermore, the debt service profile presented in Figure B does not
include additional bonds that may be issued for capital expenditures over
the following 25 years. To service LIPA's total proposed debt, each customer
would effectively pay an average of $400 in interest per year over the
life of the bonds.

DEBT SERVICE REVENUE REQUIREMENTS

The proposed LIPA transaction attempts to support reductions in rates
for the service territory over the next ten years. To a certain extent,
it appears that this results in LIPA issuing more debt than is absolutely
necessary during the period. LIPA’s documents include a projected ten-year
"revenue requirement schedule" consistent with these rate reductions,
which indicates that LIPA's obligations will exceed its revenues by over
$1.322 billion in the third through the tenth year (see Table 2). LIPA
avoids revenue shortfalls in the first and second years by shifting the
repayment of $150 million in principal on the bonds to the remaining term
of the bonds.

Part of the financing of the fund comes from diverting $284 million
in cash receivables and $40 million in operating surpluses, generated at
least in part, by not repaying principal on LIPA’s debt in the first two
years. Much of the revenue in the fund comes from cash made available from
debt service coverage requirements that are collected from ratepayers,
but presumably will not be required to meet debt service payments. These
revenues serve to cover the deficit which would otherwise require LIPA
to charge higher rates.

In its first two bond issuances alone, LIPSA borrows slightly over one-half
billion dollars for such items as working capital and capital improvements
that could have been funded with cash assets accumulated in the fund during
the first two years. As a result, LIPA effectively borrows $502 million
to be repaid over the next 35 years to subsidize rates over the first ten
years.

The net cost of this additional borrowing to ratepayers will exceed
$560 million in accumulated interest charges over the term of the bonds
after subtracting $138 million in interest earnings that are deposited
in the fund for rate relief. These interest charges are included in the
total $12.94 billion in total interest charges on the initial issuance.

To minimize revenue requirements for capital improvements to plant and
equipment in the first ten years, LIPA will issue over $1.075 billion in
additional bonds, as shown in Table 1. Consequently, LIPA will only finance,
on average, 20 percent of its total capital improvement needs over the
first ten years with internally generated cash.

In contrast, LILCO has funded all of its capital improvement needs over
the last few years with internally generated cash. Absent the proposed
deposit of cash freed from debt service coverage requirements into the
rate stabilization fund, LIPA could fund its capital improvement needs
without additional borrowing. As a result, ratepayers will pay $1.361 billion
in interest on the issuance of $1.075 billion in bonds over the 35 year
life of the bonds, placing upward pressure on rates after the rate stabilization
fund is depleted in year ten.

In addition, LIPA's rate reduction based upon reduced capital costs
will decrease the amount of cash available to retire outstanding bonds.
Over the past four years, LILCO has reduced its debt on average by $250
million per year. In contrast, LIPA will stop repaying principal on its
bonds in the first two years, with principal repayment only rising to $250
million twenty years later.

THE SIZE OF LIPA'S DEBT COMPARED TO OTHER MUNICIPAL
DEBT

The ability for the municipal bond market to absorb the issuance of
$7.262 billion over twelve to eighteen months has been noted by many financial
experts as problematic. A single large bond deal has the potential of crowding
out other municipal bond issuers, driving up interest rates and increasing
costs to taxpayers. Investors could also be adversely impacted by such
a large issuance, as the influx of bonds from the massive issue drives
down the price of other currently outstanding municipal debt from the influx
of supply. LIPA does propose to address this problem by issuing the debt
in three offerings.

In perspective, LIPA's $7.594 billion in initial debt, if issued at
one time, would dwarf all other long-term municipal bond issues ever sold
in this country. Figure C compares the new LIPA debt required to effectuate
the leveraged buy-out of LILCO to the five largest long-term municipal
bond issues in the history of the nation. This total initial financing
level would be four times larger than the average of the five largest municipal
issues ever sold.

Additionally, the $7.594 billion in new LIPA bonding would represent
almost five percent of the total $159 billion municipal volume for 1995,
the most recent year for which complete data are available. Compared to
other electric power issuers, the proposed LIPA financing level exceeds
the $5 billion total financing amount for the entire industry in 1995 by
50 percent and exceeds the largest issue for a single utility company in
that year by a factor of seven.

In an effort to ensure that the municipal bond market is able to absorb
$7.594 billion in new bonds without significant difficulty, LIPA would
sell three separate bond issues and spread the issuance of bonds for the
remaining $332 million related to the Shoreham property tax litigation
over four years.

RATEPAYERS BEAR THE RISKS IN THE LIPA DEAL

Bondholder Protections

The heavy reliance on debt by LIPA and the overall structure of the
LIPA deal increases the underlying risk. Because the value of the fixed
assets to be purchased by LIPA represents only a quarter of the overall
purchase price, bondholders will be unable to secure their position with
collateral, as is generally becoming commonplace in the industry. As a
result, LIPA includes in its initial bond issuances $674 million to provide
bondholders with the following protections that limit their risk exposure:

a debt service reserve fund, which is common practice with public authority
bond issues, totaling $640 million.

LIPA will also commit to bond covenants requiring the collection from
ratepayers of an additional 20 percent of both annual debt service payments
and payments in lieu of taxes to insure repayment of the bonds. In addition,
bondholders may require bond covenants that restrict LIPA's operating or
financial activities over the life of the bonds to limit potential out-year
risks.

Revenue Risk Exposure for Ratepayers

Achieving investment grade rating on LIPA's bonds will not only rely
upon the implied guarantee of a State public authority but will depend
more directly on LIPA's ability to impose adequate rate tariffs on customers.
The existence of a "true-up mechanism" will be the principle
credit enhancement that will adjust rates to compensate for any shortfalls
in revenues necessary to meet LIPA's obligations. LIPA's ability to collect
amounts necessary to satisfy its financial obligations in the form of a
line charge protects the bondholders, but exposes the ratepayers to "revenue
risks" resulting from many factors. The following revenue risks may
undermine the sustainability of any rate reduction.

Revenue Risk From LIPA's Capital Structure

Unlike LILCO or other electric utilities, LIPA's financial structure
will consist entirely of debt. If for any reason, LIPA is unable to satisfy
its commitment to bondholders to pay debt service on its bonds, LIPA will
have no alternative but to raise rates. LIPA, unlike an investor-owned
utility, will be unable to reduce capital costs by reducing stockholder
dividends during periods of financial distress. Consequently, Long Island
ratepayers will be vulnerable to volatile rates resulting from unforeseen
business conditions.

Revenue Risk From Competition

Increased competition both within the electric industry and between
gas, oil and electricity would enhance customer choice and reduce consumer
energy bills. However, it will exacerbate the risk to electric ratepayers,
because LIPA would not end up owning electric generation or gas assets.
These assets remain with LILCO, and LIPA proposes only to contract for
power from these sources. If a proposed merger between LILCO and Brooklyn
Union Gas is achieved, expansion of natural gas as a competing energy source
may increase the risk of revenue loss from reduced demand for electricity.

Not only would LIPA forgo enhanced revenues from the sale of natural
gas by not owning the gas assets, but LIPA would also realize an erosion
in its electric revenues as natural gas displaces electric use for certain
functions, such as heating. The inability for LIPA to spread its fixed
capital costs over a larger customer base could result in higher rates
for electric ratepayers.

Revenue Risk From New Technology and Energy Conservation

The technology of electric power generation is continually evolving
and the state-of-the-art power generation technology existing ten, twenty
or thirty years from now cannot be reasonably predicted. Technological
advances in electric generation offer potential environmental benefits
and a promise of consumer savings. Although these represent positive developments,
LIPA may be exposed to significantly increased incidence of customers getting
power by means other than purchase from LIPA. This increased risk will
place upward pressure on rates to cover LIPA's fixed costs.

In addition, aggressive energy conservation efforts offer an alternative
way to lower total energy costs for consumers. LIPA's allocation of $33
million for energy conservation and advocacy (see Table 1) could provide
substantial benefits to ratepayers. However, LIPA's success may inadvertently
increase the risk of eroding LIPA's revenue base. A reduction in revenues
from reduced electric demand may not be offset by the projected expansion
of the customer base and the related increased electric sales. As a result,
the rate tariff would have to be adjusted upward to make up for lost revenues
in order to meet LIPA's financial obligations.

Taxpayer Risk

Statewide, New York State taxpayers may be exposed to a risk of paying
higher costs of capital associated with other municipal bond issuances.
The Wall Street Journal has reported that major municipal bond issuers
have expressed concerns that the proposed LIPA bond issue could crowd out
other municipal bond issues. "Taxpayers nationwide, but mainly in
New York state, could have to fork over additional borrowing costs through
higher interest rates on their debt in order to entice new investors amid
the potential flurry of new issuance."3

In the out years, taxpayers may also be exposed to the risk of default
in the event ratepayers cannot repay the bonds. This risk is true for any
debt issued by a State public authority.

NOTES

1. A plan put forward in Suffolk County to finance bonds
through increased sales taxes would obviate the need for LIPA to issue
bonds for the Shoreham settlement.

2. The debt service costs discussed in this paper are
based upon repayment schedules provided by LIPA. The informatin provided
by LIPA makes certain assumptions about interest rates which could either
increse or decrease debt service payments depending upon market conditions
at the time of bond issuance.